A debt trap is a financial situation wherein you are unable to make EMI or credit card payments on time, resulting in ever-increasing outstanding debts. Apart from this, you will be considered debt-ridden if you do not have any money left for further savings and investment purposes. You can be caught up in such a situation if you have taken too many loans and are unable to pay for them, or are using one form of debt to pay off another. Now, what should you do to get yourself out of a debt trap? Read on.
1.Assess your finances: The first step is to understand the extent of your debt. List down all your debts, along with their interest rates and outstanding loan amount. This will tell you which loans are draining your purse the most. Then, note down your must-have expenses such as your day-to-day household expenses and insurance premiums, and calculate the total amount available for loan repayment.
2.Seek help from family and friends: Most people commit the mistake of not asking for soft loans from friends or family members. However, they should be the first people you should reach out to. Such borrowings come with no or very low interest cost and are, therefore, very handy in paying off other debts.
3.Prioritise debt repayments according to interest rates: Unsecured loans such as credit card dues or personal loan have interest rates as high as 45% and 25% respectively. On the other hand, a home loan or an education loan offers the benefit of tax deductions, thereby decreasing the cost of borrowing. Your strategy should consist of getting rid of your expensive loans first while continuing with the beneficial ones. However, continue to make the minimum payment for all the loans, else you will be penalised, further aggravating your debt position.
4.Swap high-cost loans with low-cost loans: Pay off your high interest-rate loans by availing new loans at low interest rates. For instance, if you have credit card dues carrying an interest rate of 40%–45%, pay it off by availing a personal loan. This way, you will be able to save yourself from high interest outgo. You can also go for other cheaper options such as loan against securities, gold, fixed deposits or insurance policies. The table below shows the differences in interest rates among personal loans, loan against securities and gold loans:
|Lenders||Personal Loans||Loan Against Securities||Gold Loans|
5.Liquidate your investments to pay off your debts: Use your low-yield investments to pay your loans bearing higher interest rates. If you have a fixed deposit yielding 9% returns annually and a personal loan at 18%, it will be more sensible to liquidate it to pay off your loan.
6.Restructure your loan: You can also approach your lender for restructuring your loan by extending the tenure. Though this will bring down your EMI, your net interest payout will increase. If this is not possible and you don’t have any option left, perhaps you can look at settling the loan with the lender. However, I advise against it as settling a loan greatly impacts you credit score and will make it difficult for you to get approval for any future loans.
By Naveen Kukreja, Director, PaisaBazaar.com
(First published in MoneyControl on 24 Nov 2015)